Start-up life is dynamic and unpredictable. Even the most logically constructed founding teams can have difficulty withstanding unstable market conditions, an aggressive change in the product development roadmap, or a significant pivot in the business model. The reality is that you may one day be faced with a need to terminate a co-founder.
I have advised clients from the sidelines through dozens upon dozens of founder and executive terminations. I thought I had a good idea of what the rest of the management team was going through in making this difficult decision. In carrying out my law firm's first employee termination a few years ago, however, I finally learned first-hand how heart wrenching and emotionally draining this process can be. My own experience helped me to understand exactly how important it is to keep a cool head throughout this process and adhere to a few basic rules.
Any experienced entrepreneur will tell you to "fire fast." Start-ups are all about execution and culture. Keeping on a co-founder who is no longer adding value can really stifle progress and hurt your team's morale. There are also ownership consequences with delaying the decision: your co-founder's shares will continue to vest. Dragging your feet can further dilute the rest of your team.
I would caution you, however, to be cognizant of intervening events when making the decision. You might not, for instance, want to terminate your only technical co-founder in the final week of a game-changing integration with your first big reference customer. It is a balance—you don't want to wimp out on the decision, but you should be aware of how it will impact every aspect of our organization and its external relationships.
Founders often have a tendency to want to "make the headache disappear" by simply terminating the co-founder and getting back to work. Bad idea. Future investors and acquirors are going to want things legally buttoned up. A nightmare scenario for them (and for you) involves the disgruntled, terminated co-founder who comes back to sue the company.
By entering into a separation agreement with the departing co-founder, you give them slightly more than what they are entitled to—perhaps some vesting acceleration or a few weeks' pay. In exchange, they will execute a release—a promise not sue the company. Having a valid release in place makes everyone around the table at financing or acquisition time feel a lot more comfortable.
There are some situations where foregoing a separation agreement can be very low risk—but don’t make that decision on your own—let your counsel help you gauge that. Your default option should be to always execute a separation agreement.
More than anything, your counsel can help serve as a voice of reason during this emotionally charged time. They can also help make sure that you cover all of your bases. Employment laws are tricky. Your state has various rules around last day's pay, accrued vacation, etc. Company counsel can make sure that all of the details are handled properly. Yes, you want this process to end quickly, but you also want it to end as smoothly as possible.